Colonial paper notes functioned as currency but actually were bills of credit, that is, short term public loans to the government. Previously, currency had been limited to coins with an intrinsic value based on their gold, silver or copper content; similar to the value of commodity items used in bartering. Now, for the first time, the money itself had no intrinsic value other than the value of the paper on which it was printed. Rather, the value of the notes came from the fact they were issued by and accepted by the government of the colony in payment of debts.
The process would occur as follows. The colony would authorize the printing of a specified quantity of notes which it would then use to pay creditors. The creditors would, in turn, use the notes to make other purchases and so put them into circulation. With each currency emission the colony would also authorize a tax equaling the amount of the emission. In practice individuals would pay the tax using the notes, and in this way the emission would be taken out of circulation. This system has been called "currency finance" as the currency was printed to pay government debts based on anticipated or future tax income. As long as colonies had the ability to retire older emissions the system would work. If previous emissions could not be retired when newer emissions were issued then the new emissions would simple add to the quantity of paper in circulation. A continually increasing supply (or oversupply) of paper would naturally cause prices to rise and the value of the money to decline. The key to this system was for the colonies to only print as much money as they could expect to collect in taxes.
Some emissions promised to pay the face amount plus interest, which in practice translated into a tax reduction. Of course, some individuals did not have currency and therefore paid their taxes in other ways. Farmers would most probably pay taxes with commodities, while some wealthy merchants may have been induced to pay with silver. Usually colonies offered a considerable tax reduction for those who paid in silver; in Massachusetts the discount was one third while Connecticut offer a fifty percent tax discount for payment in silver. As the total quantity of notes in an emission (say £10,000) equalled the total amount of the tax to be collected, everyone would need to pay their tax bill with paper currency in order for all of the bills to be returned during the collection of the tax. Since this never occurred there were always some bills that would stay in circulation until their redemption date. At redemption time individuals would return any notes still circulating and receive more recent paper currency with redemption dates in the future. This was done so individuals would not end up with invalid currency that could not be used.
Sometimes it has been stated the colonial treasuries paid out silver or coin for the redeemed notes. This was not the case. As individuals seldom paid taxes with silver, it was rare that a treasury would have silver to dispense and it is highly unlikely any available silver would be handed over for currency redemption. Some have been mislead in interpreting the text on the notes. Most notes only stated the bill will "pass current." However some more elaborately worded examples follow: "This Bill by LAW shall pass current in New Jersey for One ounce Fifteen Pennyweight of PLATE" (i.e. 12s) or "The Possessor of this Bill shall be paid by the Treasurer of this Colony Ten Shillings Lawfull Money" or "the Sum of FIVE POUNDS STERLING is due from this PROVINCE to the Bearer hereof." These references only refer to the value of the note, not what will be traded for them at redemption. Some late issues seem to imply a redemption in silver or gold, however this was merely a political statement bolstering acceptance for emissions that were without legal tender status or were unsecured. For example, the three Maryland emissions of 1767-1774, which lacked legal tender status, stated the following on each denomination (the text from the $8 note is given): "THIS indented BILL of EIGHT DOLLARS shall entitle the Bearer hereof to receive Bills of Exchange payable in London, or Gold and Silver, at the Rate of Four Shillings and Six-pence Sterling per Dollar for the said Bill." These notes, printed after the 1764 Currency Reform Act, lacked legal tender status, but they were secured by shares in the Bank of England that were owned by the colony of Maryland. Similarly, the completely unsecured Continental Currency notes stated (example from a $7 note): "This Bill entitles the Bearer to receive SEVEN Spanish Milled DOLLARS, or the value thereof in Gold or Silver...". The texts notwithstanding, these notes were redeemed for more current paper notes with redemption dates in the future. Indeed, following the final emission of Continental notes in 1779, one was lucky to be able to redeem them at $40 of continental currency for $1 in state paper currency of 1780 (the 1780 emission was backed by the United States specifically for the puropse of this redemption).
As long as there was a shortage of coins, paper currency was an acceptable medium of exchange; more effective for transactions than barter or wampum. It is not a coincidence that the last recorded use of wampum as money dates to 1701, which is also the first decade of the adoption of paper currency. Also, farmers and others not skilled in making the calculations necessary for converting foreign coins into colonial shillings found paper currency to be superior to coins as it was the only medium of exchange that directly correlated with each colony's money of account.
At first paper currencies were used primarily to finance military actions. In general, the British colonial Governors were not favorably disposed to authorizing emissions of currency. But the urgency of finding funds to pay for unexpected and costly defensive actions was more pressing that their dislike for paper money. In fact, the first currency produced in eight of the original thirteen colonies was printed to finance military operations. Following the lead of Massachusetts in 1690, the next colony to emit currency was South Carolina, where notes were printed in 1703, to finance an expedition to Saint Augustine, Florida. Their second emission, in 1707, was to complete the Charleston fortifications, followed by several other military related emissions including an August 1715 emission to finance fighting against Indians. In 1709, the colonies of New Hampshire, Connecticut (2 emissions), New York (3 emissions), and New Jersey all printed their first currency emissions to finance military operations in Canada during Queen Anne's War. Rhode Island followed in 1710, with its first emission to finance the Royal Annapolis Expedition, followed by five additional wartime emissions in 1710-1711. The first emission in North Carolina was a £4,000 issue in 1712, followed by a £8,000 issue in 1713, both of which were to finance the war against the Tuscarora Indians. Various emissions in the other colonies were also designated to finance military operations or repair or build fortifications. Military related emissions proliferated during the French and Indian War. In fact, the last colony to begin issuing paper currency was Virginia, which approved its first currency emission in May of 1755, to finance the military operations of General Edward Braddock, related to the onset of the French and Indian War.
In addition to military operations significant governmental expenses as those relating to the construction or repair of major public structures as workhouses or lighthouses were financed through currency emissions. The Pennsylvania issues of March 20, 1773 and March 25, 1775, were both designated to be used for the construction of the Cape Henlopen Lighthouse and the bills printed in these two emissions display a lighthouse on the back. Similarly, the Pennsylvania April 10, 1775 issue for construction of jails has a picture of the Walnut Street workhouse (that is, the Philadelphia city jail) on the back of each note. One of the more unusual and altruistic issues was the Pennsylvania issue of March 10, 1769, which was printed for "the Relief and Employment of the Poor in the City of Philadelphia" financed through contributions rather than taxes.
Other emissions were issued to replace worn out notes because some currency circulated so much it could not last until the redemption date. Often lower denomination notes were smaller in size and saw much more circulation than the higher denominations, therefore, they wore out much more quickly. In 1722, Massachusetts did not want to be forced to submit to the use of the lightweight Rosa Americana coppers produced under royal license in England by William Wood. As an alternative to these coins in June the colony printed small change 1d, 2d and 3d notes. It was realized these small change notes would have even heavier circulation that the lower denomination regular issue 1s and 2s notes, so these small change pence were printed on parchment. Also, occasionally an issue would need to be replaced before is had worn out, usually because a significant number of counterfeit notes had surfaced. At these times the issue would be recalled and a new emission was printed using a different design.